Traders work on the floor of the New York Stock Exchange (NYSE) in New York, U.S., on Tuesday, Nov. 29, 2016. Oil slid below $46 as OPEC members failed to bridge differences on production cuts. Photographer: Michael Nagle/Bloomberg

In the previous article, I discussed the recent release of the International Energy Agency’s (IEA) 2016 World Energy Outlook (WEO). The annual WEO report projects future energy consumption, production, and pricing trends based on different future scenarios. Today I will highlight the IEA's outlook for the oil markets.

This year's report considered three general scenarios, described in greater detail in the previous article. The Current Policies Scenario (CPS) depicts a path for the global energy system based on policies or measures in place as of mid-2016. The New Policies Scenario (NPS) assumes that government pledges such as those made in response to the Paris Agreement on climate change will be reflected in legislation.

The report also looked at the changes that would be required in the energy sector to limit the concentration of greenhouse gases in the atmosphere to around 450 parts per million (ppm)-- the maximum estimated level that can be allowed to keep the global temperature rise to less than 2°C.

Extrapolating the same rate of increase would imply global oil demand of about 120 million bpd in 2040. And in fact, the CPS estimates oil demand at 117 million bpd by then (along with another 3.6 million bpd of biofuel demand). Electric vehicles are forecast to rapidly increase in number, but market share grows slowly because of a large overall increase in the number of automobiles globally (a point I argued in Think Electric Vehicle Growth Will Dampen Thirst For Oil?)

The NPS assumes slower growth in oil demand, to 103 million bpd in 2040 (along with 4.2 million bpd of biofuels). Oil demand is forecast to grow at a compounded annual rate of 0.5% in the NPS and 1% annually under current policies.

For reference, the 450 Scenario would require oil demand to fall to 73 million bpd by 2040 -- highlighting the large gap between the commitments in the Paris Agreement and actions required to arrest the atmospheric carbon dioxide concentration at 450 ppm.

Demand for biofuels is projected to more than double from current levels in either case, but demands to roll back some of the aggressive biofuel mandates of the past decade have gained some momentum. So even the lower growth scenario for biofuels may be too optimistic, conditioned as it is on continuing government support.

Oil demand in advanced economies is projected to fall by almost 12 million bpd by 2040, but is expected to be more than offset by increased crude consumption in developing regions. India is projected to be the largest source of demand growth for oil (as well as coal), with a 6 million bpd increase under the NPS. Demand in Africa is projected to grow at the fastest rate, averaging 2.2% per year. However, the largest volume increase is projected to come from Asia, which is expected to require an extra 12.5 million bpd by 2040. Asia alone is expected to more than offset the decline in demand from advanced economies.

The IEA report also warns about the potential for a near-term oil price shock as investment falls short of what is needed to keep up with growing demand. If new project approvals remain low for a third year in a row in 2017, it will be hard to meet the expected demand in the early 2020s without setting off a new boom/bust cycle, according to the agency. In other words, because of a three- to six-year lag time in the oil industry between the investment decision and the resulting production, underinvestment today could lead to an oil price shock around 2021.

Under the CPS, even without an oil price shock the global price of crude oil is projected to rise to $82 per barrel by 2020, $127/bbl by 2030, and $146/bbl by 2040. The NPS assumes policies that will cause global oil demand to be lower than in the CPS. As a result, oil prices are projected to rise to $79/barrel (bbl) by 2020, $111/bbl by 2030, and $124/bbl by 2040.

Even in the NPS -- the case that is more bearish for oil -- oil prices are forecast to rise ~75% from current levels in the next three years. Combined with risk of another oil price shock in the early 2020s, this is quite a bullish forecast for the oil industry over the next five years or so.